ProfessorBainbridge.com

Padfield on Lipshaw on Corporate Purpose

Stefan Padfield writes:

Jeffrey Lipshaw has posted "The False Dichotomy of Corporate Governance Platitudes" on SSRN.  I have set forth the abstract below.  I had the pleasure of reading an early draft, and I highly recommend the paper.  Among other things, Jeff brings a level of practical experience to the topic ("more than a quarter century as a real world corporate lawyer and senior officer of a public corporation") that makes his views a must-read.  Having said that, my own view is that the “shareholder vs. stakeholder” debate is meaningful even if it only really matters in "idiosyncratic cases in which corporate leaders have managed to be either bullheaded or ill-advised."

In 2019, the Business Roundtable amended its principles of corporate governance, deleting references to the primary purpose of the corporation being to serve the shareholders. In doing so, it renewed the “shareholder vs. stakeholder” debate among academic theorists and politicians. The thesis here is that the zero-sum positions of the contending positions are a false dichotomy, failing to capture the complexity of the corporate management game as it is actually played. Sweeping and absolutist statements of the primary purpose of the corporation are based on arid thought experiments and idiosyncratic cases in which corporate leaders have managed to be either bullheaded or ill-advised. In the real world, management regularly commits itself to multiple competing constituencies, including the shareholders.

There are three arguments. The first is from reality, borne out by a survey of pre-amendment CEO annual report letters to shareholders (2017) and post-amendment responses (2020) to the COVID-19 pandemic. The second is from economics. Neo-classical economic theory supporting the doctrine is misplaced; transaction cost analysis under the New Institution Economics does a far better job of explaining the primacy of wide corporate discretion in allocating surplus among the corporate constituencies. The third is from jurisprudence. Doctrinal dicta like “corporations exist primary to maximize shareholder wealth” are not so much right or wrong as meaningless. Rather, the business judgment rule, which justifies almost any allocation of corporate surplus having an articulable connection to the best interest of the enterprise, subsumes all other platitudes posing as rules of law.

Watch this space for a related announcement coming soon.

Padfield on Politics and Corporate Governance

Stefan Padfield: The Specter of Political Bias Is Haunting Corporate Governancehttps://t.co/LcWLKkQnl2

— Professor Stephen Bainbridge (@PrawfBainbridge) July 22, 2020

Qualcomm latest company to be hit with shareholder derivative suit alleging various diversity-related board breaches of duty

I mentioned the other day that there appears to be an emerging trend of plaintiff lawsuits alleging that boards of directors have committed various breaches of fiduciary duty and/or disclosure obligations in connection with their companies' diversity or lack thereof.

The invaluable Kevin LaCroix brings word of yet another suit, this time targeting Qualcomm:

... a Qualcomm shareholder has filed a derivative lawsuit against the company’s board, alleging that the company’s directors violated their duties to the company and shareholders by falling short of stated objectives on diversity and inclusion and by falling to include a single African-American either on the board or among the company’s senior officers. The lawsuit against Qualcomm follows similar lawsuit filed earlier this month against Oracle and Facebook. A copy of the July 17, 2020 complaint against the Qualcomm board can be found here.

The complaint alleges that despite the company’s various public statements about the importance of diversity and inclusion, the company’s board includes no African-Americans (though it does include three women), and there are no African-Americans among the company’s top executives. Even the company’s Chief Diversity Officer is white. The company’s workforce is only 1.5% African American and the company has made no progress in increasing the number of African American employees since 2017. The problem, the complaint alleges, is that not just been lack of diversity but also discrimination against African Americans. ...

Like the complaints previously filed against Oracle and Facebook, this new complaint against Qualcomm is not directly tied to the current racial justice protests. There is no mention in the complaint to the Black Lives Matter movement. There is no reference to the complaint to the death of George Floyd or of the demonstrations and civil unrest that followed his death. However, the three complaint undeniably are linked to the current racial justice movement and are obviously being filed now because of the heightened visibility of racial diversity and inclusion issues as a result of the protests and demonstrations.

I am unaware of any cases determining whether either state law fiduciary duty claims or the federal disclosure claims of the sort brought here have merit. In any case, this is a very interesting development that bears watching.

Francis Pileggi's Mid-2020 Review of Key Delaware Business Law Decisions

Francis Pileggi's annual survey of important Delaware business law decisions is an invaluable way for keeping track of developments in Delaware corporate law (also contract and commercial law, if they are of interest). Occasionally, when there have been a lot of big decisions, he does a mid-year post. This year he offers up a mid-year report by Jeff Montgomery of Law360.

Here's the link.

You'll particularly want to check out his discussion of:

• Matthew B. Salzburg et al. v. Matthew Sciabacucchi, the key federal forum selection provision case
• Dell Technologies Inc. Class V Stockholders Litigation, which lays out "a sort of Field Guide to Corporate Breaches"
• In re: Tesla Motors Inc. Stockholder Litigation, in which the challenge to the Tesla-Solar City merger continues

2020 Amendments to the Delaware General Corporation Law

RLF offers a blog post summarizing the extensive 2020 amendments. The text of the bill as signed by the governor is here. The bill amends a number of important provisions:

• Improves the provisions governing emergency bylaws (useful in the coronavirus crisis era) by:
  • Clarifying when such emergency bylaws may be invoked.
  • Creating safe harbors for certain corporate actions taken during the emergency.
• Makes it easier for a conventional corporation to become a public benefit corporation (and vice versa). This provision is somewhat concerning in light of our discussion the other day of the problems PBCs have in making a credible commitment to their beneficial purpose.
• Clarifies the safe harbors for documents executed electronically.
• Clarifies which corporate officers are protected by the indemnification provision of section 145(c).

Skadden has a useful summary of the changes here.

Cydney Posner explores whether the changes to the PBC provisions will lead to a greater number of PBC IPOs.

These changes will be incorporated into the 2021 edition of the Klein, Ramseyer & Bainbridge Business Associations statutory supplement.

Delaware courts define materiality for purposes of state law claims and illustrate why I'm skeptical of juries

From JDSupra:

City of Fort Myers General § Employees’ Pension Fund v Haley, which was commenced in the Delaware Court of Chancery, grew out of the merger of equals between Towers Watson & Co. and Willis Group Holdings Public Limited Company. ...

ValueAct Capital Management, L.P., an institutional stockholder of Willis, through its Chief Investment Officer, Jeffrey Ubben, presented to John J. Haley, the Chief Executive Officer and Chairman of Towers who was spearheading the merger negotiations, a compensation proposal with the post-merger company that would potentially provide Haley with a five-fold increase in compensation. Haley did not disclose this proposal to the Towers Board.

From the Morris James blog:

A plaintiff challenging a merger when a majority of the board approving the transaction is disinterested and independent and there is no controlling stockholder on both sides cannot state a cognizable claim of breach of fiduciary duty unless it can plead facts demonstrating that the business judgment rule does not apply. 

One way to plead around the business judgment rule is to assert that a merger partner offered material compensation to the opposing party’s lead negotiator in the midst of uncertain merger negotiations to incentivize him to do as little as possible to improve the merger consideration for his stockholders. That allegation would have to be coupled with a claim that the compensation was subjectively material to the lead negotiator and that he failed to disclose it to the full board. ...

The Court defined “materiality” as “relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decision-making.”

It is interesting to compare that definition of materiality to the one in the federal securities laws, which requires a showing that there is a substantial likelihood that the reasonable investor would consider the information to be important in deciding how to vote (or to enter into a transaction or whatever). As the Haley court explained (at 31):

Although we need not look to the stockholder disclosure cases, we pause to address the parties’ competing assertions about the relevance of those cases. In Brehm v. Eisner, we noted that the term “material,” when used in the context of a director’s obligation to be candid with the other members of the Board, “is distinct from the use of the term ‘material’ in the quite different context of disclosure to stockholders in which ‘[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider itimportant in deciding how to vote.’”⁶¹ ...

In this case, although the materiality inquiry is different in the two contexts, we conclude that the allegedly omitted information would be material in either context.

⁶¹ Brehm, 746 A.2d at 259 n.49. Delaware has adopted the federal standard for materiality in the shareholder disclosure context. See Morrison v. Berry, 191 A.3d 268, 282 (Del. 2018) (“An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”) (quoting Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976))). We reject any contention in the briefing that the Delaware standard differs from the federal standard in this context.

It has never been clear to me why the materiality standard should differ in these two contexts. The opinions I've read in which the issue has come up tend to state that the two are different, but do not explain why.

BTW, here's an interesting tidbit from the Morris James post:

The fact that a dissenting Justice found that the disclosure of the Proposal was not material in light of the Towers Board’s knowledge that post-merger, Haley would be the CEO of the combined, larger entity, underscores that these judgements are not always clear-cut.

The fact that experienced jurists and lawyers who sit on the top corporate law court in the country disagreed as to the materiality of the information illustrates once again the risibility of asking lay jurors to decide whether information is material. Craziness.

The Derivative Suit Against Facebook Alleges Various Race-related Actions and Inactions = Breach of Fiduciary Duty

Kevin LaCroix has a typically detailed and thoughtful analysis of the suit:

In a recent post (here), I discussed the shareholder derivative suit filed against the board of directors of Oracle Corporation based on the alleged lack of racial diversity on the company’s board. Turns out that in addition to the lawsuit against Oracle’s board, the law firms that filed the Oracle lawsuit also have  filed a shareholder derivative lawsuit against Facebook’s board alleging that the directors had violated their fiduciary duties by their inaction on diversity and inclusion issues; their tolerance of racially discriminatory practices both in its workforce and on its platform; and their failure to take action on hate speech on its platform. Along with the Oracle lawsuit, the new lawsuit against Facebook provides another example of how the current heightened focus on diversity and inclusion issues can translate into D&O claims. A copy of the complaint in the Facebook action can be found here.

I am reminded of the old aphorism: once is happenstance, two is a coincidence, but three is a trend. The lawyers behind these suits clearly think they have a winning formula.

The likelihood is that there will be further claims like this to come. Indeed, one of the lawyers responsible for filing both the Oracle and Facebook lawsuits, Frank Bottini of the Bottini and Bottini law firm, is paraphrased in a July 8, 2020 Law.com article about the two lawsuits (here) as saying that he “plans to bring more shareholder derivative lawsuits against Silicon Valley companies who allegedly do not follow through on their diversity initiative.” ...

Of course, it remains to be seen whether other companies will be sued on similar theories as those raised in these lawsuits or how far the litigation phenomenon might spread. At this point, with only two lawsuits filed, it would be premature to suggest that these diversity and inclusion lawsuits represents an important D&O litigation trend and that the possibility of these kinds of lawsuit represents a significant potential board litigation exposure. Just the same, the filing of these two lawsuits and the possibility for more does suggest that this type of litigation could be an important emerging trend and one that is worth watching.

Even if it's not a viable claim, it may be a lawsuit the companies will want to settle to make them go away. Also, as LaCroix points out, litigation can be part of an overall package of activist tactics:

In the current focus on social and racial issues, activists will use a number of means, including claims against corporate boards, to try to advance their diversity and inclusion goals. ...

Among the things these companies will have to consider is whether to make concessions and adopt measures the plaintiffs in the respective cases have proposed, in order to try to deflect the attention and adverse publicity these kinds of cases might produce in the current environment.

The front matter for my new Advanced Corporation Law casebook: Table of content, table of cases, preface, Chapter 1

After I announced that my new Advanced Corporation Law casebook was in galleys, Tennessee law professor Joan Heminway (@VolunteerTwit) kindly suggested I post the front matter--table of contents, preface, table of cases, etc...

Glad to do it. I also included Chapter 1 as a sample. Download the front matter here.

Comments welcome; indeed, encouraged.

Tom Lin on Private Misconduct by CEOs: Does Corporate Law Have a Role in Policing It?

In his private life, a Fortune 500 CEO commits a truly heinous act. It has no connection to the company or the CEO's professional life, except in that newspaper accounts will mention that the CEO is President of Acme.

Has the CEO breached his fiduciary duties to the company and its shareholders. Did the board of directors breach their oversight (aka Caremark) duties by failing to monitor the CEO's private life?

I have dabbled in this area before. In my 2011 post, Can the Berkshire board be held liable for Sokol's trades?, I addressed a question posed by Kevin LaCroix in connection with the case of former Berkshire-Hathaway executive Sokol who resigned after purchasing Lubrizol stock in advance of recommending that Berkshire acquire Lubrizol. LaCroix asked:

Can the directors – or any one of them (say, for example, Buffett) possibly be held liable for failing to take actions that allegedly could have prevented supposed harm to the company?

At the time, my answer was no:

Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart 833 A.2d 961 (Del.Ch. 2003), strikes me as being on all fours with the Sokol case. The Stewart case arose out of Martha Stewart's insider trading troubles. Plaintiff claimed that "the director defendants and defendant Patrick breached their fiduciary duties by failing to ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business." (970-71) In other words, plaintiff claimed that the MSO directors failed to fulfill their Caremark duties by failing to prevent Stewart from engaging in insider trading.

The Chancellor opined that:

The “duty to monitor” has been litigated in other circumstances, generally where directors were alleged to have been negligent in monitoring the activities of the corporation, activities that led to corporate liability.Plaintiff's allegation, however, that the Board has a duty to monitor the personal affairs of an officer or director is quite novel. That the Company is “closely identified” with Stewart is conceded, but it does not necessarily follow that the Board is required to monitor, much less control, the way Stewart handles her personal financial and legal affairs.

And he continued by observing that "it is unreasonable to impose a duty upon the Board to monitor Stewart's personal affairs because such a requirement is neither legitimate nor feasible. Monitoring Stewart by, for example, hiring a private detective to monitor her behavior is more likely to generate liability to Stewart under some tort theory than to protect the Company from a decline in its stock price as a result of harm to Stewart's public image."

Maybe you could argue that Sokol's conduct is somewhat less personal, because he traded in stock of a company he knew he would be pitching to Berkshire as a takeover candidate. OTOH, however, Sokol is far less “'closely identified' with" Berkshire than Stewart was with MSO.

So I think there is zero chance that a Caremark claim against the directors of Berkshire-Hathaway.

For more on Caremark claims see my articles The Convergence of Good Faith and Oversight and Caremark and Enterprise Risk Management.

In my 2004 post, Latest Hollinger News, I examined claims arising out of Lord Black's labyrinthine empire - among them the sale of some assets to Canadian media group CanWest for $1.8bn in 2000. I explained that:

According to minutes of a board meeting four months earlier, directors were told Lord Black and others would receive a total of $53m in non-compete fees and that further payments would go to Ravelston, his private company. Cardinal claims there was never any independent analysis of the size or need for these payments. The claim .... alleges that investors lost out through "misappropriation of corporate assets as well as self dealing - arrangements, for example, where company executives sold company assets to other companies where they had an interest".

In self-dealing claims such as this one, the shareholders have a cause of action against the directors or officers who misappropriate corporate assets or pursue conflicted interest transactions. The claim against the non-participating directors is more complex. Most self-dealing transactions do not require director approval as a matter of law, although many corporate conflict of interest policies go beyond what the law requires. Instead, approval by the disinterested directors provides a partial safe harbor if the transaction is challenged by a shareholder (such approval shifts the burden of proof from the director with the conflict of interest to the shareholder). Ordinarily, the failure of the directors to make an informed decision in this regard is invoked merely to vitiate the safe harbor rather as grounds for an independent cause of action against the approving directors. Yet, under Smith v. Van Gorkom, directors' duty of care requires that when they make a decision they do so on an informed basis. Likewise, the Caremark decision plausibly could be interpreted as imposing an affirmative duty on directors to investigate conflict of interest transactions and to ensure that the conflicted directors do not take advantage of the corporation.

The Hollinger lawsuit thus could be distinguished from the recently dismissed case against Martha Stewart (blogged here). In the Stewart case, the shareolders' suit alleged that Martha Stewart Omnimedia's disclosure documents routinely stressed the importance of Martha Stewart to the company's success. After the controversy over Stewart's trading in ImClone stock broke, MSO's stock price dropped precipitously, ultimately bottoming out at a 65% loss. The suit alleged Caremark violations by MSO directors and execs (click here for a discussion of Caremark), who allegedly failed to "ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business." In dismissing, Chancellor Chandler explained that: (1) plaintiff had failed to allege facts that would have put the board on notice of potential wrongdoing; and (2) the Delaware precedents speak to wrongdoing in a corporate capacity, not in an exec's personal life. Based on what we know thus far about the suit against the Hollinger board, it sounds like both of those criteria will be satisfied. Because the alleged misconduct involved self-dealing with corporate assets and because it is alleged the directors were aware - even approved ex post - of some of the transactions, a strong case is already made out that the board had a duty to investigate and make an informed decision as to the proper course of action.

Tom Lin has posted an article, Executive Private Misconduct (June 11, 2020), available at SSRN: https://ssrn.com/abstract=3624533, that takes an in-depth look at this issue. In particular, he sweeps quite broadly to pick up not just the Caremark issues, but a number of other relevant theories of liability on which either the executive and/or the board of directors could be sued (unsuccessfully in most cases).

ABSTRACT Executives misbehave. In recent years, the world has been outraged and appalled by the shocking misbehavior of corporate executives. Some of their behavior have been plainly unethical; others have been deeply offensive; and still others have been simply criminal. Regardless of the misbehavior, such executive private misconduct—when made public—has frequently damaged their public reputations, harmed their company’s market values, destroyed investor portfolios, and raised serious legal and policy issues.

This Article provides one of the first comprehensive examinations of ex- ecutive private misconduct and its wide-ranging effects on law, business, and society. It begins by providing context for how we got here. It investigates how the unfolding #MeToo movement, shifting social understandings of public and private, and changing corporate social expectations have all fostered a new landscape that is less tolerant of executive private misconduct. Next, it examines why legal gaps and tensions in current business law complicate executive private behavior discussions. It reveals how corporate law principles of fiduciary duties and securities law principles of disclosures were not structurally designed to confront the hard issues and questions raised by executive private misconduct. Moving from causes to consequences, this Article next examines the larger implications of executive private misconduct on corporate governance, corporate policies, and corporate purpose. Finally, this Article recommends pragmatic next steps for corporate stakeholders, regulators, and policymakers in a changing business environment. Specifically, it proposes a new baseline framework for working through perplexing executive private misconduct issues, along with concrete business policy reforms concerning nondisclosure agreements, mandatory arbitration, and annual misconduct reports. Ultimately, this Article seeks to provide an original, workable roadmap and compass for conceptualizing, navigating, and addressing executive private misconduct and its impact on law, business, and society.

Tom concludes--I think correctly--that "The two bodies of law and regulation that govern much of American business—state corporate law and federal securities law—were largely designed to address the professional obligations and duties of executives and not the private matters of their personal lives."

With respect to the Caremark duty issues, with which my blog posts were mainly concerned, Tom doesn't discuss the Martha Stewart case, which strikes me as a bit odd, especially since he discusses that case in the preceding section on the executive's duty of loyalty. Nevertheless, I agree with his conclusion that "the law and business conventions suggest that such monitoring [i.e., board monitoring of an executive's private life] may be unnecessary and undesirable."

This is an extremely useful addition to the literature and highly recommended.

My new casebook Advanced Corporation Law is in galley

I'm very excited to announce that I've gotten the galleys for my forthcoming casebook on Advanced Corporation Law. It will be coming out in the fall for Spring 2021 adoptions.

This text is designed for use in an advanced course in corporate law and governance. It assumes that students have taken a basic course in Corporations or Business Associations.

Corporate governance has been much in the news in recent years and lawyers are devoting increasing amount of attention to it. The passage of major federal legislation in 2002 (the Sarbanes-Oxley Act a.k.a. SOX) and 2010 (the Dodd-Frank Act) were particularly important developments, generating much new law and, as a result, much new legal work. Curiously, however, the law school casebook market has largely ignored these trends.

Corporate governance is regulated by many of the same laws covered in the basic Business Associations course, but increasingly is also regulated by laws¾such as SOX and Dodd-Frank¾that get short shrift in the typical Business Associations casebook and course. In contrast, those laws are the core focus of this text.

Unlike the more basic topics that dominate Business Associations, which are a product of state corporate law with a minor federal overlay, corporate governance is regulated by a much more complex body of law that emanates from multiple regulators. Many of the rules of corporate governance come from traditional state corporate and federal securities law sources, but many more come from sources such as stock exchange listing standards or rules issued by the Public Company Accounting Oversight Board and similar quasi-governmental bodies. All of these are grist for the mill in this text.

Importantly, however, lawyers practicing in the corporate governance space must be knowledgeable not only about the law but also best practice. As Sir Adrian Cadbury observed in connection with the United Kingdom’s adoption of the so-called Cadbury Code, it is tempting for managers to obey the letter of law while ignoring the deeper purposes behind it. Sound corporate governance structures thus must be informed as much by best practices as well as formal legal rules.

Likewise, this text assumes that mastering the relevant law requires situating it in an understanding of the contemporary business environment. The legal issues governing executive compensation makes little sense, for example, if one does not understand the political and economic debate over CEO pay. Similarly, to cite just one more example, mastering the high-profile issues respecting shareholder rights will be much easier if the students are familiarized with the changing demographics of shareholders and the rise of activist hedge funds.

Notice that I refer to this book as a text rather than a casebook. Although the text includes many canonical cases presented in the traditional format, the case method is not the only—or even always the best—way of teaching students to draft workable contracts and disclosure documents, conduct due diligence, or counsel clients on issues that require business savvy as well as knowing the law. Accordingly, the book also relies on textual explication, sample documents, and problems to build student transactional skills.

This approach is driven by my belief that, because lawyers plan at least as often as they litigate, advanced business law course texts need to adopt a transaction planner’s perspective. Most law school casebooks—even in the corporate law area, where the authors ought to know better—have an inherent bias towards litigation perspectives due to their emphasis on cases. I avoid that by using additional sources, such as law review articles and regulatory materials, and by including numerous problems—typically at the start of a block of material—requiring students to think about how the materials will affect real world transactions and planning.

The text assumes familiarity with some basic law and economics tools—such as transaction costs and agency costs—that are commonly used in many business law classes. Indeed, the central theme of this text is the agency costs resulting from the separation of ownership and control in public corporations. The appendix offers a brief overview of these tools for the benefit of those students who have not encountered them previously.

Congratulations to Columbia Law, the Millstein Center, and Leo Strine

I once wrote that:

When any Chief Justice of the Delaware Supreme Court speaks on a corporate law topic, lawyers and academics who toil in that doctrinal vineyard listen. When that Chief Justice is Leo Strine, they listen especially closely. The “well-respected” Chief Justice after all is the “[w]underkind of U.S. corporate law” and has been “recognized among academics, practitioners, and other judges” as an “intellectual leader” of the Delaware judiciary.

Stephen M. Bainbridge, Corporate Social Responsibility in the Night-Watchman State, 115 Colum. L. Rev. Sidebar 39, 39 (2015).

I remain a greater admirer of now retired CJ Strine, who--perhaps excepting only the late Chancellor William Allen--has made more and better law than any jurist in my lifetime (although even mighty Homer nods occasionally).

I am therefore quite envious of Columbia Law School and its Millstein corporate governance program, which today announced that "Former Delaware Supreme Court Chief Justice Leo E. Strine, Jr. will join the center as the Ira M. Millstein Distinguished Senior Fellow."

While at Columbia, Strine will collaborate with the Millstein Center in a variety of ways, including conducting research in the areas of business law and corporate governance, speaking at academic events, and engaging with business leaders. In conjunction with joining Columbia Law School, Strine will hold a joint affiliation with the University of Pennsylvania Carey Law School, where he has been named the Michael L. Wachter Distinguished Fellow in Law and Policy. ...

Reflecting on his joining Columbia Law School, Strine said, “For years, I’ve been honored to work with the outstanding business law faculty at Columbia on a variety of projects and to participate in their classes and programs sponsored by the Millstein Center. I’m excited to work even more closely with them, including because the law school, in general, and the Millstein Center, in particular, recognize how important fair economic and corporate governance systems are for the proper functioning of our society.”

To be on the same faculty as CJ Strine would be a treat for any corporate law scholar. I must admit to feeling more than a little jealous of the folks at Columbia. But maybe we can entice the CJ to visit Los Angeles  occasionally.

Can a corporation be insane?

Mihailis Diamantis has posted an article to SSRN entitled The Corporate Insanity Defense and also posted a summary to the Oxford corporate governance law blog:

... there are some criminal corporations whose deep or unpredictable disfunction presents a special challenge. These corporations are much less likely to respond constructively to criminal sanctions. In a forthcoming article—The Corporate Insanity Defense—I argue that criminal law needs a different approach for these corporations, one that emphasizes compulsory expert treatment rather than standard forms of punishment. 

It's an interesting article, but I start from a premise founded on the aphorism famously attributed to Edmund, First Baron Thurlow: "Corporations have neither bodies to be punished, nor souls to be condemned." Applying the criminal law to corporate entities fits poorly with most of the basic purposes of criminal law.

• Deterrence: Corporations can act only through persons. It is those corporate agents who must be deterred. Entity level punishment will be less effective as a deterrent than direct punishment of the responsible corporate actors.
• Retribution: You can't send a corporation to jail. But you can send the responsible corporate actors to jail.
• Rehabilitation. Lacking a body and soul, the corporation has nothing that can be rehabilitated. But bad human actors can be rehabilitated.
• Restitution: Obviously, the corporation can provide restitution to those it harmed. But that would require directing corporate fines and penalties to the victims of wrongdoing rather than the government.

We should seriously rethink corporate criminal liability, which effectively amounts to vicarious liability, and replace it with direct liability for the individuals who are responsible for the wrongdoing.

California considering legislation to adopt underrepresented community board of director quotas--Internal Affairs Doctrine Issues

Keith Paul Bishop reports that:

In 2018, the California legislature enacted SB 826 (Jackson) which imposed gender quotas on corporate boards of directors of "publicly held corporations".  See California Enacts Novel Female Board Quota Legislation.  The constitutionality of that legislation is now before the courts.  See Secretary Of State Must Answer Legal Challenge To Female Director Quota Law.

On Monday, Assembly Member Chris Holden gutted and amended AB 979 to impose a similar quota requirement on domestic and foreign publicly held corporations having their principal executive offices in California.  Similar to SB 826, corporations will be required to have a minimum of one director from an underrepresented community no later than the close of the 2021 calendar year.  By the close of the 2022 calendar year, the minimum numbers would be as follows:

• Three, if the corporation's number of directors is nine or more;
• Two, if the corporation's number of directors is more than four but fewer than nine; and
• One, if the corporation's number of directors is four or fewer. 

The bill would also impose similar reporting requirements on the Secretary of State and subject violators to significant fines.

The bill defines a "director from an underrepresented community" to mean an individual who is African-American, Hispanic, or Native American. 

California law (SB 826) currently imposed gender quotas on boards, although that provision is currently being challenged in court.

As a corporate lawyer, what jumps out at me is the provision applying the new requirement to foreign publicly held corporations having their principal executive offices in California. As with SB 826, this raises a serious constitutional issue under the dormant commerce clause. I discussed the issues raised by SB 826 in a WLF Legal Pulse brief:

Virtually all U.S. corporations are formed (“incorporated”) under the laws of a single state by filing articles of incorporation with the appropriate state official.  The state in which the articles of incorporation are filed is known as the “state of incorporation.” Selecting a state of incorporation has important consequences, because of the so-called “internal affairs doctrine”—a conflicts of law rule holding that corporate governance matters are controlled by the law of the state of incorporation. Virtually all U.S. jurisdictions follow the internal affairs doctrine, even if the corporation in question has virtually no ties to the state of incorporation other than the mere fact of incorporation.

A few states make a more general exception to the internal affairs doctrine for so-called pseudo-foreign corporations. A foreign corporation is one incorporated either by a state or nation other than the state in question. A pseudo-foreign corporation has most of its ties to the state in question rather than to the state of incorporation. Many Delaware corporations are pseudo-foreign corporations. They are incorporated in Delaware, but most of their operations are located in one or more other states.

In most states, there is no significant legal difference between a foreign and a pseudo-foreign corporation, and the internal affairs doctrine will be applied to invoke the law of the state of the incorporation with respect to both. California and New York are the principal exceptions to this rule. Both states purport to apply parts of their corporate laws to pseudo-foreign corporations formed in other states but having substantial contacts with California or New York.

SB 826 is an especially aggressive attempt to regulate pseudo-foreign corporations. California’s basic pseudo-foreign corporation statute—Cal. Corp. Code § 2115—applies only to corporations that have more 50 percent of their property, payroll, and sales in California and have more than half of their shareholders of record held by California residents. In addition, §2115 does not apply to public corporations. In contrast, SB 826 applies to public corporations whose sole contact with California is the location of its principal executive office. Given that § 2115 is almost certainly unconstitutional under the dormant Commerce Clause, the more aggressive SB 826 should also be unconstitutional.

In the leading CTS Corp. v. Dynamics Corp. decision, the U.S. Supreme Court recognized that it “is an accepted part of the business landscape in this country for states to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” 481 U.S. 69, 81 (1987).Building on that fundamental principle, the Court emphasized that a state has a legitimate “interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” Id.

Note that the Court acknowledges the legitimate interest of a specific state; i.e., the state under whose law the company was incorporated:

Large corporations that are listed on national exchanges, or even regional exchanges, will have shareholders in many States and shares that are traded frequently. The markets that facilitate this national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that a corporation — except in the rarest situations — is organized under, and governed by, the law of a single jurisdiction, traditionally the corporate law of the State of its incorporation.

Id. at 90. To be sure, the Court here may be referring not to constitutional principle, but rather to the conflict of laws principle known as the internal affairs doctrine, “which recognizes that only one State should have the authority to regulate a corporation’s internal affairs—matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders—because otherwise a corporation could be faced with conflicting demands” from different states. Edgar v. MITE Corp., 457 U.S. 624, 645 (1982).

But while the Supreme Court has not held that it is unconstitutional for a state other than the state of incorporation to attempt to regulate a corporation’s internal affairs,² a number of commentators have concluded that the internal affairs rule rises to the level of a constitutional doctrine.³

Admittedly, there is not much case law on this issue, and the leading case comes from a very interesting party—i.e., the Delaware Supreme Court—but that case held that attempted application of California’s § 2115 to a company incorporated in Delaware violated the U.S. Constitution’s Due Process and Commerce Clauses:

Pursuant to the Fourteenth Amendment Due Process Clause, directors and officers of corporations “have a significant right … to know what law will be applied to their actions” and “[s]tockholders … have a right to know by what standards of accountability they may hold those managing the corporation’s business and affairs.” Under the Commerce Clause, a state “has no interest in regulating the internal affairs of foreign corporations.” Therefore, this Court has held that an “application of the internal affairs doctrine is mandated by constitutional principles, except in the ‘rarest situations,’” e.g., when “the law of the state of incorporation is inconsistent with a national policy on foreign or interstate commerce.”

VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108, 1113 (Del. 2005). Assuming Delaware to be correct on the constitutional status of the internal affairs doctrine, SB 826 is unlikely to survive judicial scrutiny.

AB 979 is subject to the same argument.

Also, as with SB 826, AB 979 defines a “publicly held corporation” as "a foreign corporation with outstanding shares listed on a major United States stock exchange." The problem with that definition, of course, is that there is no such thing as a "major United States stock exchange." It's simply not a defined term of art anywhere. 

VC Laster's Dell Decision Gives a Very Director Primacy Spin on MFW

In his recent opinion in In re Dell Techs. Inc. Class V Stockholders Litig., 2020 WL 3096748 (Del. Ch. June 11, 2020), Vice Chancellor Laster gave a very board-centric spin on the MFW rule. Tyler O'Connell's Morris James blog post explains:

The Delaware Supreme Court’s MFW decision provides a safe harbor for controlling stockholder buyouts that are conditioned upon approval of a special committee of independent directors and a majority-of-the-minority vote, provided, inter alia, “there is no coercion of the minority.” Kahn v. M & F Worldwide Corp. (MFW), 88 A.3d 635, 645 (Del. 2014). The Court of Chancery’s recent decision in In re Dell Tech. Inc. Class V. S’holders Litig., 2020 WL 3096748 (Del. Ch. Jun. 11, 2020), held that a redemption of minority stockholders’ shares failed to satisfy MFW due to the company’s decisions to give the special committee an impermissibly narrow mandate and then bypass it to negotiate directly with minority stockholders. 

The Vice Chancellor didn't cite my work on director primacy, but the opinion is very much in the spirit of director primacy:

MFW’s dual protections contemplate that the Special Committee will act as the bargaining agent for the minority stockholders, with the minority stockholders rendering an up-or-down verdict on the committee’s work. Those roles are complements, not substitutes. A set of motivated stockholder volunteers cannot take over for the committee and serve both roles.

The MFW framework contemplates that the special committee will act as “an independent negotiating agent whose work is subject to stockholder approval.” Flood, 195 A.3d at 767. Through the involvement of the special committee, the MFW framework ensures that there are “independent, empowered negotiating agents to bargain for the best price and say no if the agents believe the deal is not advisable for any proper reason ....” MFW, 88 A.3d at 644 (internal quotation marks and emphasis omitted). Like a board of directors in an arm’s-length transaction, the committee has superior access to internal sources of information, can deploy it’s the Board’s statutory authority under Section 141(a) as delegated to the committee under Section 141(c), and can “act as an expert bargaining agent.” In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604, 618 (Del. Ch. 2005); see 8 Del. C. § 141(c). Like a board of directors, the committee “does not suffer from the collective action problem of disaggregated stockholders” and is therefore well positioned “to get the last nickel.” Id. at 619; see also In re Pure Res., Inc. S’holders Litig., 808 A.2d 421, 441 (Del. Ch. 2002) (“Delaware law has seen directors as well-positioned to understand the value of the target company, to compensate for the disaggregated nature of stockholders by acting as a negotiating and auctioning proxy for them, and as a bulwark against structural coercion.”).

He then described the shareholders' role in the MFW framework as being "more limited":

They have “the critical ability to determine for themselves whether to accept any deal that their negotiating agents recommend to them.” MFW, 88 A.3d at 644 (internal quotation marks omitted). But “the ability of disaggregated stockholders to reject by a binary up or down vote obviously ‘unfair’ deals does not translate to their ability to do what an effective special committee can do, which is to negotiate effectively and strike a bargain much higher in the range of fairness.” Cox Commc’ns, 879 A.2d at 619.

Laster's interpretation of the relative board and shareholder roles is consistent with the approach I outlined in The Geography of Revlon-Land, 81 Fordham L. Rev. 3277 (2013):

In their efforts to decide who decides, the Delaware courts have grappled with the limits of a target corporation's board of directors' power to act as a gatekeeper in corporate acquisitions. In other words, to what extent can the target's board of directors prevent the target's shareholders from deciding whether the company should be acquired?

In a merger, two corporations combine to form a single entity. In an asset sale, the selling corporation transfers all or substantially all of its assets to the buyer. In both transactions, approval by the target board of directors is an essential precondition.

In both major forms of statutory acquisitions, the board thus has a gatekeeping function. Shareholders have no power to initiate either a merger or asset sale, because the statute makes board approval a condition precedent to the shareholder vote. If the board rejects a merger proposal, the shareholders thus have no right to review that decision. Instead, the shareholder role is purely reactive, coming into play only once the board approves a merger proposal.

The board also has sole power to negotiate the terms on which the merger will take place and to enter a definitive merger agreement embodying its decisions. Shareholders have no statutory right to amend or veto specific provisions, their role typically being limited to approving or disapproving the merger agreement as a whole . . . .

If the board disapproves of a prospective acquisition, the would-be acquirer therefore must resort to one of the nonstatutory acquisition devices. The proxy contest, share purchase, and tender offer all allow the bidder to bypass the target board and make an offer directly to the target's shareholders. Since the 1960s, the tender offer has been the most important and powerful of these tools. Almost as soon as the hostile tender offer emerged as a viable acquirer tactic, however, lawyers and investment bankers working for target boards began to develop defensive tactics designed to impede such offers. If validated by the courts, these takeover defenses promised to reassert the board's primacy by extending its gatekeeping function to the nonstatutory acquisition setting.

Consider the poison pill, for example, which has been called the “de rigeur tool of a board responding to a third-party tender offer.” … Proponents of pills contend that these plans thus do not deter takeover bids, but rather simply give the target board leverage to negotiate the best possible deal for their shareholders or to find a competing bid. In any case, it is clear that “the poison pill has made the board the ‘gatekeeper’ instead of the shareholders.” As a result, target boards have been empowered to play an active--and often determinative--role in the very class of transactions originally designed to bypass them entirely.

Judicial Watch has Standing to Bring Suit Against the California Board of Director Gender Quota Law

Keith Paul Bishop reports:

Last August, I reported on the filing of a taxpayer challenge to California's Board Gender Quota Law.  Crest v. Padilla, Cal. Super. Ct. Case No. 19STCV27561.  California's Secretary of State, Alex Padilla, was named as the defendant in his official capacity.  The plaintiffs allege that the law (SB 826) violates Articles 7 and 31 of the California Constitution.  In October of last year, Secretary Padilla filed a demurrer to the suit, arguing that the plaintiffs lack standing and that the action is not ripe.  Last week, Superior Court Judge Maureen Duffy-Lewis overruled the Secretary of State's demurrer ....

The Secretary of State, who is represented by the Attorney General, will be required to answer the complaint and we may all eventually get an answer to the question of the law's constitutionality.

Regular readers will recall that I have argued that the internal affairs doctrine has constitutional status and that the California statute is an unconstitutional violation thereof.